After breaking-out to new highs yesterday, as expected, $SPY (-0.7% @ $174.2) has come back down to test resistance-cum-support from its dual rising wedge trendlines. The intraday technicals have prompted me to take my finger off the buy button, because the setup has grown more precarious.

The S&P 500 ($SPX) has moved sideways since I started tracking its bearish setup two weeks ago. Naturally, the patterns have morphed since then, but the overarching theme remains: this is a battleground. Mainstream media are starting to question the market’s resilience amid this little bit of stagnation. I’ve offered my intermediate-term outlook, but I wanted to refresh my short term technical appraisal.

This is an absolute pain trade right now. The Dow just reached alltime highs two days ago, having magnanimously reversed a poor overnight session in the futures markets (ES low -63bps). DJIA printed new-er highs again today. Since Dow 14k made front page headline news, alltime highs gets a horse & pony show complete with fireworks shooting out of asses (pun intended). It’s times like this that not only test your process as a money manager, but also your psychological mettle.

I’m just trying to figure out what’s next. I still fully expect a QE3-lite a la HAMP, assuming the Fed is the agency forced to act. More on that later in this entry.

Technicals are a powerful tool because they communicate the psychological undercurrents in capital markets–which psychology often leads to predictable action. (I think of the Bank of Japan’s predictable interventions in FX markets as a good example.) To start, here’s what US capital markets are telling me:

I hold a half-sized position in TLT that I’ll be adding to in the near future. 30-year Treasury Yields (TYX) have given pause to the T-bond rally, in anxious anticipation of the Fed’s next move. While my analogues are still powerfully bullish alongside the long-term technical fractals, I see a short-term oscillation up as high as TYX 3.80-3.87 resistance from today’s 3.61:

TYX daily- due for short correction up to 3.80-3.87

That poses a substantial threat to short-term fixed income performance, but I choose to hang onto my positions given unequivocally bullish long-term charts.

In its most deterministic [monthly] fractal, the S&P 500 (SPX) stochastic shows remarkable ability to persist in overbought territory, clearly due to the monetary support savior:

SP v Fed Funds Effective Rate

Any Fed-led solutions henceforth will not call upon the Fed Funds Rate, as it’s zero-bound. (Quantitative Easing was the progression of monetary policy beyond ZIRP.) This persuades me to prepare for continued equity weakness.

Throughout this Diary, I’ve adequately communicated my thoughts about policymakers’ actions in addressing this [rolling] crisis. I’m adamant that monetary policy doesn’t render sustainable economic resurgence, rather, it builds a temporary bridge over troubled waters, which allows the economy to dam-up the floods and continue its merry way. The operative word therein is “temporary.” I suggest that the Greenspan Fed thought it had a magical recipe for prosperity. On the backside of the Volcker Fed’s interest rate hike, Mr. Greenspan deployed monetary easing that was anything but temporary–in fact, it was secular, chronic, disinflationary. It disincentivized innovation; it coaxed the proliferation of financialization; so on and so forth. I need not reiterate this part of the case.

When Mr. Bernanke penned his famous 2001 “Helicopter Ben” essay, I opine that he was cognizant of the limitations of monetary policy (i.e. providing temporary bridge support). The economy eventually needs to take the handoff. Much like our assumption ‘the housing market grows perpetually,’ Mr. Bernanke seemingly assumed the economy would find growth like a pig sniffing out truffles in a French field. Like that pig, a poorly trained economy would defer to its habit of playing in the mud, rather than roaming for mushrooms.

I’m setting-forth a few insinuations here. While price-stability & employment embody the Fed mandates, secular economic pursuance lay beyond both its capability and its design. I treat the Federal Reserve with more empathy than most of my contemporaries. The Fed has tested the breadth of its legally-authorized faculties to render more than two years worth of relative price stability and unemployment moderation. I ask, what tool in the Fed’s authorized toolbox can promote greater effects on the economy than this? None.

More than a generation of Americans now is accustomed to monetary policy as a driver of prosperity, and we’ve become pigs habitually rolling in mud. At this point, I recommend the only effective solution: intervention via fiscal policy. Policymakers need to retrain the economy by guiding it to moneymaking truffles. Surely, there have been sounder conditions for the US Treasury to invest (on margin), but this is the mudpuddle in which we’re stuck.

The grand conclusions is as follows… Mr. Bernanke would probably prefer to undertake further easing measures as soon as tomorrow. Yet core inflation has finally upticked, the Fed’s dissenters/critics are rebelling, and QE has empirically proven its inability to affect economic sustainability. Given his resources, his responsibility and his critics, Mr. Bernanke will defer further easing until either his critics are silenced by a crises or Congress rallies to complement the Fed’s efforts… otherwise, the Fed would be draining resources to continue pushing on a string.

In his last delivery of the Fed minutes, Mr. Bernanke already guided investors’ expectations in asserting the ZIRP regime through mid-2013. Tomorrow, he will re-emphasize the Fed’s ability to extend the composition (duration) of its holdings–a “Twist,” as it’s being called. So far, the Fed tactics are all according to the playbook proffered by FRBNY SOMA manager Brian Sack back in June.

Tie that back into the signals being broadcast by markets:

Treasuries & Gold/Silver pulling-back after steep ascents: Long-dated Treasuries are most attractive to me given technical determinism in monthly fractals. Gold really shot for the moon this month, perhaps a bit overdone. Silver has reloaded after margin-hikes & margin-calls, and I really expect it to catchup in the coming days.

Corporate credit looking bearish in coming days-week.

Equities show little resolve in intermediate/long term, but short-term is quixotically constructive.

You’ll notice the contradiction between the short-term technicals and the anecdote about American policy intervention (the lack thereof). I’m still trying to sort thorough the storylines to figure out what’s going to push equities higher in the coming days. The Dow Jones Industrial Average (DJIA) looks particularly strong for that period. Perhaps I’ll have more to come…